Europe’s central bank cuts rates

Frankfurt (Sept 4)  The European Central Bank unexpectedly cut its benchmark interest rate by 10 basis points to a record 0.05 percent to boost the region’s economy.

The central bank will also start buying assets, easing the flow of funding for the region’s economy while holding back for now on larger-scale action.

The ECB “will purchase a broad portfolio of simple and transparent securities,” president Mario Draghi said at a press conference in Frankfurt. While the measures announced will have a “sizable” impact on the balance sheet, “some of our council were in favour of doing more than presented,” he said. The euro dropped below $US1.30 for the first time since July 2013.

In committing cash to the market for asset-backed securities, Draghi is making good on his pledge to help rekindle an asset class that can funnel loans to the real economy and ease funding conditions for banks. While the size of the plan wasn’t given, it probably doesn’t represent the kind of quantitative easing that could directly fend off the threat of deflation.

Euro-area inflation languished at 0.3 per cent last month, far below the ECB’s 2 per cent target. The ECB downgraded its forecasts for growth and inflation from its previous assessment in June.

Weaker outlook

Gross domestic product is now forecast to expand by 0.9 per cent this year and 1.6 per cent in 2015, instead of the previous 1 per cent and 1.7 per cent. Inflation is expected to be weaker in 2014, forecast at 0.6 per cent this year instead of 0.7 per cent previously. The inflation outlook for 2015 is unchanged at 1.1 per cent.

“We took into account the overall subdued outlook for inflation, the weakening in the growth momentum in the recent past,” Draghi said. “The Governing Council sees the risks around the economic outlook on the downside.”

The ECB earlier reduced all three of its main interest rates by 10 basis points. The benchmark rate was lowered to 0.05 per cent and the deposit rate is now minus 0.2 per cent.

The euro fell as low as $US1.2996 and traded at $US1.3027 at 3.19pm Frankfurt time.

Amid a war between Russia and Ukraine on the euro-area’s eastern flank, mounting deflation risks and faltering output in Germany, Draghi finds himself forced to act for the second time in three months to shore up the economy. In June the ECB announced a three-year loan scheme, called TLTRO, that hinges on banks lending on funds to households and businesses.

Credit easing

Draghi said details of the ABS program will be announced after the October rate-setting meeting. The securities are backed by underlying instruments such as mortgages or credit- card debt, and are packaged into products containing slices with different risk profiles. Draghi said on August 7 this process in the future has to be “simple, transparent and real,” and not “a sausage full of derivatives.”

“Today’s measures are predominantly oriented to credit easing,” Draghi said, adding that initially the central bank is targeting the least risky segment of these assets. Only if governments present a guarantee would the ECB consider buying lower tranches, such as the so-called mezzanine.

The ECB didn’t reach unanimous agreement on the asset- purchase plan, Draghi said. In July, Bundesbank President Jens Weidmann called ABS purchases “problematic” and warned against supporting bank profits while socializing the losses.

Issuance of ABS instruments collapsed in the wake of the financial crisis, when they were blamed for being a non- transparent way of transferring risk to investors who didn’t know what they were buying. JPMorgan Chase & Co. estimates that the market has shrunk by more than 40 percent since 2010.

“We want to make sure that these ABS are being used to extend credit to the real economy,” Draghi said. On the size of the program he said that “we’d love to give a figure, for communication purposes. At this stage it’s very difficult to assess the size.”

Source:  Bloomberg